It is a fair question to ask if Costco (NASDAQ:COST) can keep the good times rolling. COST stock is expensive and there is a raging storm of inflation and supply chain instability battering the stock market.
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The big box retailer’s stock has increased 44% in the past 12 months and currently trades at $514.64 a share. That brings the stock’s gains over the past five years to nearly 200%. By any measure, COST stock has been a winner and provided shareholders with tremendous value. The growth has continued nearly unabated over the last decade. But with inflation now at its highest level since 1982, higher interest rates coming down the pike, and global supply chains strained, analysts are rightfully wondering if Costco can continue to outperform in the face of increasingly strong headwinds?
Is COST Stock Overvalued?
Some analysts are claiming that Costco stock is overvalued today even after it has pulled back nearly 10% so far this year with the ongoing market churn. Skeptics point to COST stock’s price-to-earnings (P/E) ratio of 44 as evidence that it is an expensive purchase for investors. The average P/E ratio among stocks in the S&P 500 index is a much more modest 15. Costco’s P/E ratio is much higher than comparable national retailers such as Kroger (NYSE:KR), which has a P/E of 35, and Dollar General (NYSE:DG), whose P/E stands at 20.
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By those comparisons, Costco does look pricey.
Analysts ascribe the high valuation to the fact that Costco’s business performed gangbusters during the pandemic as people stocked up to shelter in place at home, as well as a cult like following among both consumers and investors. The high valuation is of concern as Costco faces a number of challenges this year that include an inflation rate that reached 7.5% in January, a 40-year high, as well as wage and fuel inflation, and ongoing issues with global supply chains.
Will Costco’s customers remain loyal to the big box retailer if it raises prices for its various goods, as well as its annual membership fees?
Pricing Power and Loyal Members
This is not the first time that Costco has had to manage inflation, and the company’s loyal clientele gives it incredible pricing power.
Among Costco members, 91% renew their membership each year. These members pay for the privilege to shop at the company’s more than 800 retail outlets. That membership renewal rate is the envy of the retail world. And members have shown that they will stick with the company even if it does raise prices. Last year, to help manage inflation, Costco increased its average membership fee (they are tiered) by 10%. That increase provided Costco with an additional $3.8 billion in revenue during 2021. And, by all indications, membership renewals remain above 90%.
Costco is the rare company that reports on its progress monthly. On Jan. 30 of this year, the company reported net sales of $92.1 billion, which was an increase of 16.4% from $79.11 billion generated in the first month of 2021. This is a good indication that Costco is managing to weather the current storm. For all of 2021, the Seattle-based company grew its revenues by 17.4% year-over-year to $196 billion. Costco’s revenue growth has averaged 10% over the past five years.
Key to the company’s future growth is its e-commerce strategy. Costco’s e-commerce sales in 2021 were 200% higher than in 2019 before the pandemic, accounting for 7% of total revenue, up from 4% in 2019.
COST Stock Remains a Safe Bet
Like all businesses, Costco faces some challenges in the current environment. And its stock has been tossed higher and lower as markets continue to be volatile. But the problems Costco faces are not insurmountable. Its loyal customer base and pricing power are already helping it steer a profitable course through the inflation storm. And while it’s stock is not cheap, the company’s exceptional revenue and profit growth justifies the high P/E ratio.
Looking ahead, there is every reason to believe that, yes, Costco can continue to outperform and deliver exceptional value to shareholders.
COST stock is a buy.
On the date of publication, Joel Baglole did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Joel Baglole has been a business journalist for 20 years. He spent five years as a staff reporter at The Wall Street Journal, and has also written for The Washington Post and Toronto Star newspapers, as well as financial websites such as The Motley Fool and Investopedia.
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